Tjalling C. Koopmans Research Institute Tjalling C. Koopmans Research Institute Utrecht School of Economics Utrecht University Kriekenpitplein 21-22 3584 EC Utrecht The Netherlands telephone +31 30 253 9800 fax +31 30 253 7373 website www.koopmansinstitute.uu.nl The Tjalling C. Koopmans Institute is the research institute and research school of Utrecht School of Economics. It was founded in 2003, and named after Professor Tjalling C. Koopmans, Dutch-born Nobel Prize laureate in economics of 1975. In the discussion papers series the Koopmans Institute publishes results of ongoing research for early dissemination of research results, and to enhance discussion with colleagues. Please send any comments and suggestions on the Koopmans institute, or this series to [email protected] çåíïÉêé=îççêÄä~ÇW=tofh=ríêÉÅÜí How to reach the authors Please direct all correspondence to the first author. Dr. M.P.Lycklama à Nijeholt Leiden Law School Institute for Tax Law and Economics Department of Business Studies Kamerlingh Onnes Gebouw Steenschuur 25 2311 ES Leiden The Netherlands. e-mail: [email protected] Dr. Y.K.Grift Utrecht University Utrecht School of Economics Kriekenpitplein 21-22 3584 TC Utrecht The Netherlands. E-mail: [email protected] Prof. Dr. J.M.J. Blommaert Tilburg University PO Box 90153 5000 LE Tilburg The Netherlands. E-mail: [email protected] This paper can be downloaded at: http:// www.uu.nl/rebo/economie/discussionpapers Utrecht School of Economics Tjalling C. Koopmans Research Institute Discussion Paper Series 12-21 GOODWILL MEASURING VALUE CREATION OF ACQUISITIONS: AN EMPIRICAL RESEARCH M.P.Lycklama à Nijeholt a Y.K.Grift b J.M.J. Blommaertc aLeiden Law School Leiden University b Utrecht School of Economics Utrecht University c Financial Accounting Tilburg University August 2012 Abstract The reason for this research is that at the beginning of the 21st century, some important changes were introduced in the international standards of accounting affecting reporting on goodwill. The intentions of the standard-setting bodies in drafting the new rules were that the financial statements would better reflect the underlying economics of the acquired goodwill.1 In this research it is tested whether goodwill under the new accounting regime does reflect underlying economics and therefore provides information on expected value creation of the acquisition. The results of the research show that goodwill contains elements of value creation: characteristics of valuecreating acquisitions have a positive effect on purchased goodwill. However, also other characteristics determine the amount of purchased goodwill. Keywords : Goodwill, Mergers and Acquisitions, SFAS 141, SFAS 142, Value Creation JEL classification : G34, M41, M48 GOODWILL MEASURING VALUE CREATION OF ACQUISITIONS: AN EMPIRICAL RESEARCH 1. INTRODUCTION This workingpaper is about goodwill as ameasureof valuecreation. In 2001, some important changes havetakenplace in the US accountingregime[UnitedStates Generall y AcceptedAccountingPrinciples (US GAAP) 2001]. 1 Due to theintroductionof SFAS 141 “Business Combinations” and of SFAS 142 “ Goodwill and Other IntangibleAssets” 2, acquiringcompanies are obliged toprovidemore extended as well as moreuniform informationconcerningthemergers andacquisitions intheir annual accounts. Changed US GAAP (2001) requirethat all business combinations must be reported inthe sameway, namely throughthe purchasemethod. Moreover, theacquiringcompany must provideinformationabout thereasons for theacquisitionandmust allocatethe purchase price to the assets andliabilities of the target at their fair value. Purchasedgoodwill, then, should represent the purchaseprice of the acquiredfirm minus thefair valueof its net assets. Besides, stricter regulationregardingtheseparate reportingonpurchasedidentifiable intangibleassets will further reducethe amounts of purchasedgoodwill, as these intangibles will nolonger beaccountedfor as part of goodwill. In addition, an impairment test should leadtoa comparison of thecarryingamount of goodwill withits fair value, basedonthe present valueof thefuturecashflows arisingfrom the acquisition. This impairment test is performed annually, andwhenever there is an indicationthat areporting unit might be impaired. As aresult of these changes, the informationcontent of purchased goodwill may have increased. Moreinformation onpurchasedgoodwill may beavailable, andgoodwill may have becomea more conciseterm that contains relevant informationabout expectedvalue creation or synergy of theacquisition. This would correspondto the intentions of the standard-settingbodies indraftingthenew rules: they expect that under thenew standards, thefinancial statements will better reflect theunderlyingeconomics of the acquiredgoodwill. 3 Theintentionof this workingpaper is to gainaninsight into the informationcontent of purchasedgoodwill under thechanged accountingregime withregard to thevaluecreation of theacquisition for thebusiness combination: does goodwill under thenew accounting regimeprovideinformationonexpected valuecreationof the acquisition? Theresearchis confined to mergers andacquisitions betweenUS publicly quoted companies, to whichUS GAAP apply. it focuses onmergers andacquisitions that were announcedandbecame effectiveintime period2002-2005, thus after new regulationcame intoforce. This study intogoodwill measuring valuecreation of acquisitions was conducted inthree steps. First , correlations of purchasedgoodwill withstock excess returns werecarriedout. Second, bivariate analyses regardingcorrelations betweenpurchased goodwill and 1 Recently, accounting regulation regarding reporting on business combinations was further modified. In November 2007, FASB issued a revised SFAS 141 ‘Business Combinations’ (SFAS 141R). SFAS 141R is beyond the scope of this research. However, the changes resulting from these revised standards indicate that the trend of future-oriented fair value accounting and separate recognition and measurement of intangible assets is continued. 2 SFAS 141 (2001) superseded APB Opinion No. 16 “Business Combinations” (1970). SFAS 142 (2001) superseded APB Opinion No. 17 “Intangible Assets” (1970). 3 SFAS 142, 2001, summary, 2. 1 characteristics of value-creatingacquisitions, as well as other characteristics affecting goodwill, werecarriedout. Third, multivariate regressions of purchased goodwill onthesecharacteristics were performed. Characteristics of value-creating acquisitions (arisingfrom the efficiency theory and relatingto financial synergies, operatingsynergies, and improvedmanagement) and of other theories explaininggoodwill werederivedfrom literatureconcerningresearch ontarget stock returns andbid premiums. The results of the research show that goodwill contains elements of value creation: characteristics of value-creatingacquisitions have apositive effect on purchasedgoodwill. Financial synergies andpartly operatingsynergies explainpurchasedgoodwill. Further, if it is proposed that improved management not only flows from acquirer to target but also from target toacquirer, improvedmanagement seems toberepresented inpurchasedgoodwill as well . Theseconclusions hold after controllingfor other characteristics suchas bargainingand agency motives. This study adds to research literature in three respects. First, whereas most studies into acquisitiontheories aretestedfor thesetheories by usingrelationships betweenaccounting reports andstock returns, inthis researchstock returns arereplacedby purchasedgoodwill. The possibility of goodwill turning out to be anadequate alternativetostock returns when measuringvalue creation will beexaminedhere. Second, thus far, most of theresearchinto goodwill was about goodwill explaining market value or excess returns of the company. 4 Market value and excess returns then weremeasured by stock prices or returns on stock prices. Thestudies werefocusedon theimpact of thereportedasset “goodwill” of acompany onits market value(valuationanalysis) or excess return (returnanalysis). Aninnovation of this dissertationis: (a) that it focuses onpurchasedgoodwill in acquisitions insteadof onthe reported asset goodwill in the financial statements of a company created in the course of time, and(b) that it examines whether this purchased goodwill resembles theexpectedvalue creation by these acquisitions. So purchased goodwill is now used as a variable to be explainedinsteadof as anexplanatory variable. Third, theresearchers believethat goodwill data on which the empirical research is based are unique. In current databases, no information regarding goodwill purchased in acquisitions can be found. Only information about goodwill as reported on the balance sheet of companies is available. The time- consuming search for purchased goodwill data in the notes to the consolidated financial statements of theacquiringcompanies makes this research the only oneof its kind. Thestructureof this workingpaper is as follows: section2 provides some different definitions of goodwill. Insection3, thesignificant features of thechangedUS GAAP regardingfinancial reporting affecting goodwill are specified in more detail. Section 4 discusses acquisition theories and previous research into these theories that contribute to explain purchased goodwill. Moreover, here thehypotheses areformulated. In section5, theestimationmodel is described. This is followedby thedatainsection6. Section7contains adiscussionof the results of the research. Theworkingpaper closes withthe conclusions insection8. 2.